Perspective on 2001 Tax Act

The 2001 Act repeals the estate and GST tax for decedents dying after December 31, 2009. The top marginal estate tax rate, now 55%, will decrease incrementally to 45% in 2007. The estate tax exemption, now $1 million, will rise in three stages to $3.5 million in 2009, before complete repeal in 2010. The GST exemption will mirror the estate tax exemption beginning in 2004.

The gift tax exemption, $1 million for 2002, will not rise again. After 2009, the gift tax will remain, with a marginal rate of 35%. Until 2010, gift and estate taxes will remain partially unified, in that lifetime gifts will reduce the estate tax exemption.

Under the Act, new IRC §2632(c) will automatically allocate a donor’s GST exemption to lifetime transfers made to generation-skipping trusts if those transfers are not direct skips. However, various exceptions apply. For example, no automatic allocation will occur if the trust provides for distribution or withdrawal by a person under 46 of more than 25% of the trust corpus (or before a specified date reasonably expected to occur before the individual reaches 46). Also under the Act, new IRC §2632(d) permits a retroactive allocation of GST exemption to a transfer in trust under certain circumstances.

New §§1014(f) and 1022 resurrect carryover basis provisions for inherited property after 2009. However, the executor will be able to designate specific assets whose basis equals $1.3 million which will receive a stepped-up basis. The $1.3 million amount is increased by unused capital losses and net operating losses. Also, “qualified spousal property” with a basis of up to $3 million passing to a surviving spouse will be entitled to a basis step-up. Accordingly, even after repeal in 2010, it may still be desirable for wills and trusts to provide for a separate marital share to utilize the $3 million basis allotment. Likewise, it may also be prudent to specify whether the executor should allocate the lowest value of assets necessary to absorb the $3 million additional basis adjustment, or whether the assets set aside for the marital share should be representative of total appreciation and depreciation. Without such a provision, the potential value of the marital share could fluctuate significantly, creating problems for the executor.

Under the Act, the state death tax credit will be reduced in 25% increments until it is eliminated in 2005. However, beginning in 2005, state death taxes will be deductible under new IRC §2058. New York’s estate tax, though a “sponge” tax, is correlated to federal law as it existed in 1998. Accordingly, New York will continue to impose a death tax on estates which exceed $1 million. An estate of $1.5 million could therefore incur no federal estate tax, but a substantial state death tax. In fact, unless New York law is changed, a New York death tax could be owed even after repeal of the federal estate tax.

The Act also imposes new reporting requirements for lifetime gifts and transfers at death. Donors of lifetime gifts will be required to furnish donees with a written statement detailing information on the gift tax return. Similarly, with respect to transfers at death of non-cash assets in excess of $1.3 million, the executor would be required to include on the decedent’s final income tax return certain information, including the name and taxpayer ID of the recipient of the property, a description of the property, and the adjusted basis and fair market value of the property at the decedent’s death. Failure to comply with reporting requirements would result in the imposition of substantial penalties unless reasonable cause was established.

The Qualified Family Owned Business deduction of §2057 is repealed for estate of decedents dying after 12/31/2003.

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